Journal of Accounting and Economics 12 (1990) 309-337.

NorthHolland

MANUFACl-URING OVERHEAD COST DRIVER ANALYSIS

George FOSTER and Mahendra GUFTA*

Stanford University, Stanford CA 94305, USA

Received September 1988, final version received March 1989

This paper empirically examines hypotheses from the accounting, manufacturing, and strategy
literatures about volume-based, complexity-based, and efficiency-based drivers of manufacturing
overhead costs. Cross-sectional data from a questionnaire of thirty-seven facilities of an electron-
ics company are examined. Subject to caveats regarding the cross-sectional tests, strongest
empirical association is found for volume-related cost drivers. There is not consistently strong
empirical association for complexity- or efficiency-related drivers. Explanations for the limited
association for the complexity- and efficiency-related drivers include proxy problems with the
complexity and efficiency concepts and problems in developing uniform measures of variables
across a broad cross-section of facilities.

1. Introduction

Manufacturing overhead (MOH) represents a significant cost category in

many companies. This cost category is attracting considerable attention in the
accounting, manufacturing, and strategy literatures. This paper empirically
examines hypotheses from these literatures about three classes of MOH
cost-drivers; these three classes are termed volume-, complexity-, and effi-
ciency-based cost drivers. Results for 34 variables that operationalize these
three classes of cost drivers are reported.
Existing cost and management accounting texts focus on volume-based
variables (e.g., number of units of output or direct material dollars) in their
expositions of many topics, e.g., flexible budgeting, variance analysis, and cost
estimation. Critics of existing texts and of current practice stress both the
limitations of this heavy focus on volume-based variables and of the additional
insights from recognizing complexity (e.g., number of vendors or number of
products assembled) or efficiency (e.g., production cycle time or scrap cost)

*George Foster is Paul L. and Phyllis Wattis Professor of Accounting and Mahendra Gupta is a
Ph.D. student at Stanford University. This paper benefited greatly from our interactions with
munerous personnel of Electronics Inc. Workshop participants at A&M-University of New South
Wales, Harvard University, Stanford University, University of Alberta, University of California at
Berkeley, University of Rochester, and University of Western Australia, and participants at
CAM-I conferences in London and San Diego provided many helpful comments and suggestions.
The detailed comments of A. Atkinson, R. Ball, W. Beaver, S. Beckman, N. Dopuch, C. Horngren.
M. Jensen, R. Kaplan, M. McNichols, E. Noreen, P. Reiss, P. Stamats, R. Watts, M. Weiss and
J. Zimmerman (the referee and editor) were much appreciated.
A cost driver is defined to be any activity that results in costs being incurred.

0165-4101/90/$3.50~1990, Elsevier Science Publishers B.V. (North-Holland)

310 G. Fmter and M. Gupta, Cost driver anatjsis

variables.* The empirical support presented in the literature for these criti-
cisms is limited. In particular, there is minimal empirical evidence on the
relative importance of complexity- or efficiency-based variables vis-a-vis vol-
ume-based variables in explaining MOH differences across different facilities
or of the same facility over time.
This paper uses the largest firm-specific MOH data base reported to date in
the literature. Cross-sectional data from 37 facilities of a multinational elec-
tronics company (called Electronics Inc.) are examined. There are two major
sets of findings. First, there is strong empirical association between volume-
based variables and MOH levels across facilities. Second, after controlling for
scale differences, there is not a strong association between complexity or
efficiency variables and MOH levels across the 37 facilities of Electronics Inc.
Two explanations for this second finding that warrant much attention in
subsequent research are noted in this paper, i.e., (i) the problem of identifying
variables that adequately capture the complexity and efficiency concepts and
(ii) the problem of developing consistent measures of complexity and efficiency
variables across a cross-section of different facilities.
Subsequent sections of this paper are structured as follows. Section 2
discusses MOH cost drivers and summarizes the limited existing empirical
evidence in this area. The methodology underlying our research is outlined in
section 3. Descriptive statistics on Electronics Inc. and details of the cost
driver variables used to probe the descriptive validity of hypothesized MOH
cost driver relations are in section 4. Issues that arise in using cross-sectional
data to empirically examine cost driver relationships are discussed in section 5.
These issues include scale differences across the facilities and differences in
their cost functions. Results are presented and examined in sections 6 and 7.
Section 8 makes general comments about field-based management accounting
research. Summary comments are in section 9.

2. MOH cost drivers

The MOH cost drivers examined in this paper are drawn from hypotheses
and comments found in the accounting, manufacturing, and strategy litera-
tures3 At least three classes of MOH cost drivers are viewed as important:

MOH=f(v,C, E),

See, for example, Cooper and Kaplan (1987) Johnson and Kaplan (1987). and Berliner and
Brimson (1988).
%ources in the accounting literature include cost accounting texts and research papers included
in National Association of Accountants (1986), Bruns and Kaplan (1987), Capettini and chancy
(1987). and Berliner and Brimson (1988). Manufacturing sources include Clark, Hayes, and
Lorenx (1985). Hayes and Wheelwright (1984). Hayes, Wheelwright, and Clark (1988). and
Schonberger (1982, 1986). Strategy sources include Abegglen and Stalk (1985) and Porter (1985).
 G.Faster andM. Gupta,Cast&ver analysis 311

where
Y = volume-related drivers,
C = complexity-related drivers, and
E = efficiency-related drivers.
Volume-related drivers can relate to either the size of the facility or the level of
output from the facility. A positive correlation is hypothesized between V and
MOH.
Complexity can arise in a variety of areas that influence the level of MOH.
Five areas of complexity are identified in this paper: product design, procure-
ment, manufacturing process, product range, and distribution. A positive
correlation is hypothesized in each of these areas between the level of complex-
ity and MOH.
Eficiency refers to the relation between inputs and outputs. The lower the
level of inputs for a given level of outputs, the more efficient the operations.
The manufacturing literature currently is emphasizing two areas related to
efficiency:
1. Time-bused: Activities that reduce the through-put time for assembling
products are viewed as increasing efficiency.
2. Nonualue-added: Eliminating activities that result in costs being incurred
without any change in the product or service as perceived by the customer
is viewed as increasing efficiency.
More efficient operations are hypothesized to have lower levels of MOH.
The volume, complexity, and efficiency classes of cost drivers need not be
mutually exclusive. For example, efforts to increase efficiency can involve
reduction in one or more areas of complexity. Nor are the volume, complexity,
and efficiency classes of cost drivers viewed as collectively exhaustive. For
example, variables related to the work force (such as the relative use of quality
circles or cost reduction circles) potentially explain MOH differences across
facilities or over time.
The above model of MOH cost drivers is presented in its most general form.
At this stage in research, little is known about exact functional relations or
about how these three classes of MOH cost drivers interact with each other.
Correlation analysis is adopted in this paper. We view this approach as
appropriate, especially given the small number of data points (maximum of
37) available for each variable. Our analysis is more modest than an attempt to
estimate an hypothesized MOH cost function for the 37 facilities of Electron-
ics Inc.

2.1. Existing evidence

The published literature contains many suggestions about potential MOH
cost drivers. However, almost without exception, there is a little systematic
312 G. Faster and M. Gupta, Cost dnveranalysis

data analysis presented to support their suggestions. One of the 8rst detailed
studies was Miller and Vollmann (1985) - field investigations included exten-
sive tours and interviews at four plants in the electronics industry (p. 145).
The authors proposed a transactions-based approach to MOH costs:
In the hidden factory, where the bulk of manufacturing overhead costs
accumulates, the real driving force comes from transactions, not physical
products. These transactions involve exchanges of the materials and/or
information necessary to move production along but do not directly result
in physical products. (p. 144)
Much of the Miller-Vollmann research involved identifying the many areas
where MOH-related transactions could be generated. Emphasis was placed on
complexity-based transactions. However, they provided no evidence that plants
with fewer transactions have lower MOH costs.
Cooper and Kaplan (1987) illustrate how the use of complexity-related
variables to allocate indirect costs can affect the estimates of individual
product costs. One complexity example (Schrader Bellows) presented was
based on machine setups:
Low-volume products create more transactions per unit manufactured
than their high-volume counterparts. The per unit share of these costs
should therefore be higher for the low-volume products.. , Most of the
transactions that generate work for support departments can be proxied
by the number of setups. For example, the movement of material in the
plant is often related to the commencement or completion of a produc-
tion run. (pp. 218-219)
An officer of Schrader Bellows recomputed product costs using the number of
setups to allocate a sizable percentage of the support-department costs to
products. The change in the reported product costs ranged from about minus
10 percent to plus 1,000 percent (pp. 219-220). However, there was no
empirical documentation in the paper that MOH costs for Schrader Bellows
changed over time as a function of changes in the number of machine setups.4

3. Research methodology
In March 1987, Corporate Manufacturing and a facility of Electronics Inc.
jointly administered a questionnaire survey. This survey was sent to 38
separate facilities that were located in the continental U.S.A. The introduction

See also Banker and Johnston (1988) and Banker, Datar, Kekre. and Mukhopadhyay (1989).
 G. Fmter and M. Gupta, Cart driver analysis 313

to this questionnaire included the following:

Over the past couple of years there has been an increasing amount of
interest in understanding our manufacturing cost structure and the
drivers of manufacturing costs.. . The primary objective of the survey is
to collect data on a facility basis that will allow us to analyze manufactur-
ing overhead costs company-wide.
The variables included in the questionnaire were selected by Electronics Inc.
personnel based on (a) their interest in testing the descriptive validity of MOH
cost driver notions they heard discussed at many manufacturing conferences
they attended and (b) their knowledge of the facilities of Electronics Inc.
Responses were received from 37 facilities. The data base developed from
the responses has a maximum of 292 items for each facility. All data is
cross-sectional and relates to fiscal 1986; no time-series data on each facility
was requested in the questionnaire.
After the questionnaire was administered, the authors were given access to
the data to analyze for research purposes. Three approaches were used to gain
additional insight into Electronics Inc. and the data provided - tours of
facilities, interviews with plant personnel, and interviews with corporate per-
sonnel. Visits were made to 12 of the 37 plants that responded to the
questionnaire. The plant tours were especially useful in both (i) selecting
variables to reflect concepts such as product complexity and time-based
efficiency and (ii) understanding how heterogeneity may arise in the way
variables are measured across facilities.
Interviews were conducted with manufacturing and accounting personnel at
each of the 12 plants visited. Topics of concern included perceptions about the
importance of individual cost drivers and the problems encountered in re-
sponding to the questionnaire. Corporate personnel at Electronics Inc. helped
to give insight into the motivations and administration of the questionnaire
and problems encountered in prior efforts to analyze data from a broad
cross-section of the facilities of Electronics Inc.
The analysis is based on simple and partial cross-sectional correlations
between MOH costs and volume, complexity, and efficiency variables. As with
any empirical correlation study, caution is appropriate in drawing inferences
about causality. Inferences about causality are strongest if the 37 facilities use
a homogeneous production process. That is, each plant has basically the same
production function. Section 4 presents evidence consistent with there being
considerable diversity across facilities in their production functions. This
reduces our ability to draw strong conclusions about causality from our data
analysis.
Appendix A of this paper outlines the data-screening procedures we used
after receiving the 1Qpage questionnaire returned by each of the 37 facilities.

J.hE.-N
314 G. Foster and M. Gupta, Cost driver analysis

4. Descriptive statistics on Ektmnics Inc.

4. I. Components of manufacturing costs

Manufacturing overhead costs at Electronics Inc. are measured by subtract-

ing direct costs from total manufacturing costs.5 Direct costs comprise direct
materials costs at all facilities and direct labor costs at 33 of the 37 facilities.
Distribution statistics on the components of total manufacturing costs across
the 37 facilities of Electronics Inc. are:
Deciles of distribution
Cost category Mean 0.1 0.5 0.9

Direct materials 0.543 0.272 0.574 0.705

Direct labor 0.066 0.021 0.065 0.116
Manufacturing overhead 0.391 0.265 0.360 0.637

The above mean percentages are equal-weighted averages of the percentages at

each facility.6 Interfacility transactions are not eliminated when computing
these percentages. This nonelimination biases upward the direct materials
percentages; the direct materials purchase figure for an interfacility transac-
tion will include labor and MOH costs of the source facility.
Fig. 1 presents a percentage breakdown of the total manufacturing costs
into the direct material, direct labor, and MOH categories across the 37
facilities. This figure illustrates the considerable cross-sectional diversity in the
facilities examined in this research. This diversity reduces our ability to draw
inferences about causality from empirical associations between MOH and cost
driver variables.

SElectronics Inc. has a set of guidelines for measuring aggregate overhead costs at each facility.
These aggregate categories are total MOH, procurement MOH, production MOH, and support
MOH. However. there is some dearee of tlexibilitv in measurinn the subcateaories of these MOH
cost categories. For allocating M6H costs to products, EIectroks Inc. hasno rigid requirement
that is uniformly adopted.
?he above distribution statistics follow Electronics Inc.s policy of including direct labor
payroll taxes and benefits as a component of MOH. The inferences drawn in this paper were
unchanged when direct labor payroll taxes and benefits were excluded from MOH and included
as a component of direct labor cost; under this definition the mean ratio of direct labor costs to
total manufacturing costs is 0.113.
Electronics Inc. has facilities that assemble computer-related products and facilities that
assemble instrument-related products. The American Electronic Association (1985) reports the
following average manufacturing cost structure for firms in these two industries:
Computers (41 respondents) Instruments (97 respondents)
Direct materials 0.675 0.545
Direct labor 0.065 0.131
Manufacturing overhead 0.260 0.324
Electronics Inc. is similar to the average firm in the AEA survey in that manufacturing overhead
is the second most important category of manufacturing costs.
 G. Foster und M Gupta, Cost driver analysis 315

Pert
100

60

40

CFacility 1 Facility 37 3

n %DlRECTMATERlALq %DlRECTlAKW I%MCH

Fig. 1. Percentage analysis of total manufacturing costs into direct materials, direct labor, and
overhead categories for 37 facilities.

4.2. MOH cost categories and cost driver variables

Electronics Inc. groups MOH into three general categories - procurement,
production, and support. Fig. 2 presents the subcategories within each of these
three general categories. These subcategories are ranked in terms of their
average percentage importance within that general category. For product

1. STORES 1. DIRECT LABOR PAYRCLLTAXES l.PRCDmrmpIG*IEER*IG

2. PuRCtaSlNG AND BENEFITS 2.PRmESSEraHEwEK3
3. MATERIALS ENGINEERING P.OCCuPANCY 3. CENTRAL EDP. SUPPORT
4. MATERUUSMANAGEMENT 3. DIRECT LASOR SUPERVISION 4. MArwFACnKu.JG MAraGEMENl
5.-CONIROL 4. OTHER INDIRECT LASCR 5.CUALtTYASSMANCE
6. MATERIAL
SPECIFlCATlCN 5.wERATlNGMPEbmS
7. HSCUND FREIGHT 6. DEPRECIATION
8. TRAFFIC AND RECEIVING 7. PRaxcTmMANAGEMENT
9. -TE MATERULS 9. EOUlPMENT EXPENSES
9. SHIPPING

Fig. 2. Procurement.production.and support MOH categories; subcategories ranked in order of

importance within category.
316 G. Foster and M. Guptu, Cost driver analysis

EFacility 1 Facility 373

m % Procurement MOH % Production MOH n % Support MOH

Fig. 3. Percentage analysis of total manufacturing overhead into procurement, production, and
support for 37 facilities.

costing purposes, support MOH is first allocated to either procurement MOH

or production MOH. In most facilities, procurement MOH is allocated to
products on the basis of direct material dollars, while production MOH is
allocated on the basis of direct labor dollars.
Four categories of MOH costs are separately examined in this paper:
1. total MOH,
2. procurement MOH,
3. production MOH, and
4. support MOH.
Total MOH is the sum of procurement, production, and support MOH. Fig. 3
presents a percentage breakdown of the three MOH subcategories across the
37 facilities. Panel A of table 1 has distribution statistics on the four MOH
categories. Both fig. 3 and panel A of table 1 reinforce the previously drawn
inference .that there are considerable cross-sectional differences in cost struc-
ture of the 37 facilities examined in this research.
Thirty-four variables that capture the volume, complexity, or efficiency
classes of MOH cost drivers are examined in this paper. Appendix B provides
a listing of these variables. Distributional data relating to these variables is in

Facilities differ in the way support MOH is allocated. For example, one facility uses
headcount in procurement and production, while another facility uses dollar MOH costs in the
procurement and production categories as the allocation base.
The data in table 1 has been transformed to preserve confidentiality. The inferences were not
changed by this transformation.
 Table 1
Descriptive statistics for MOH cost pools and accounting and manufacturing variables.

Percentiles
K-Sb
Category/variables N Mean 0.10 0.50 0.90 .7

Panel A: Manufacturing overhead

MOHI Total man~acturiq overhead 37 16721 6075 13968 35636 1.14
MOH2 Procurement overhead 37 4100 1111 3459 7558 0.74
MOH3 production overhead 37 7504 2095 5612 18769 1.14
MOH4 Support overhead 37 5117 2029 3978 10601 1.11

Panel B: Volume

Plant size
VI.1 Total manufacturing space 37 103017 33698 76200 211287 1.12
VI.2 Avg. total headcount in mamhcturing 37 453 143 340 1079 1.05
VI.3 Installed machinery and equipment 37 6578 1870 5267 15566 1.12
Plant output
V2.I Direct labor dollars 33 2847 598 1952 7346 0.92
V2.2 Direct material dollars 36 29560 4738 25689 64681 0.97
V2.3 Total ending inventory dollars 35 14247 2936 10870 30234 1.00

Panel C: Complexiy

Product design complexity

Cl.1 # of part nos. on materials record tile 35 12061 2363 10120 26426 0.82
Cl.2 Avg. prod.: # of material structure levels 33 5 3 5 8 0.65
Cf.3 Avg. prod.: Total # of part numbers 31 852 56 450 2483 l&F
Procurement complexity
c2.1 Total number of vendors 1053 155 600 3025 1.18
c2.2 # of part nos. represexhg 80% of usage :: 1521 106 536 32wo 1.8T
C2.3 Avg. number of purchase orders/month 33 1314 268 1250 2277 0.61
C2.4 %ofpartsiqectedonreceipt 35 19% 1% 10% 64% 1.92=
c2.5 % of parts preformed before value-added 34 28% 1% 20% 73% 1.04
 Table 1 (continued)
!z
Percentiles
K-Sh
Category/variables N Mean 0.10 0.50 0.90 ;
Manufacturing process complexity
c3.1 External subcontracting as %of D/M 31 10% 0% 5% 28% 1.41
c3.2 Corp. subcontracting as % of D/M 29 41% 10% 40% 70% 0.62
c3.3 Avg. # of material flow transactions/month 31 46720 2100 45000 103000 0.84
Product range complexity
c4.1 # of products on consumer price list 32 217 54 725 1.81 Q
C4.2 Avg. # of options shipped/month 33 2801 750 6120 2.08
c4.3 Avg. # of accessories shipped/month 35 10582 150 5380 2.84= 2
c4.4 # of CPL products with 80% of business 30 24 14 50 1.07 5
c4.5 # of new products introduced this year 33 3 2 9 1.43c g
Distribution complexity 2
c5.1 Avg. # of customer orders processed/month 35 1675 1256 4460 1.13 a
c5.2 % of orders which were internal 36 32% 4% 100% 1.52 3
c5.3 Total number of customers 33 2416 20 7093 1.18 F
-p
Panel D: Eficienq
F$
E
Manufacturing ejiciency
E1.I Avg. prod.: Cycle time in days 33 20 0.76 6 66 2.18 1
El.2 % of mfg. eng. time on process improvement 36 20% 10% 20% 35% 1.05 p
El.3 % of CIM effort on quality/process 9
improvement 36 33% 0% 30% 72% 0.77 5.
Nonvalue-added activities
E2.1 Months of supply of inventory maintained 36 2.60 1.10 2.80 3.76 0.61
E2.2 WIP as % of total ending inventory 31 26 6 22 55 0.87
E2.3 # of production change orders/avg. month 36 39 6 34 -II 0.65
E2.4 % products built to stock 33 45% 0% 30% 97% 0.94
E2.5 Total rework dollars 32 188 31 137 450 0.94
E2.6 Total scrap dollars 32 193 14 166 455 0.83

Number of observations.
bKoImogorov-Smirov z-statistic.
CSigniticant at 5% level.
 G, Fosrer and M. Gupta, Cost driver analysis 319

panels B to D of table 1. Marked differences across the facilities exist for these
variables. For example, the 0.10 and 0.90 de&s for the number of products
are 7 and 725, respectively.
The Kolmogorov-Smimov test for normality [see Siegel (1956)] is also
reported for the variables in table 1. The complexity set of variables show the
most departure from normality; nine of the nineteen variables in this category
(see panel C of table 1) reject the normality assumption at the 0.05 significance
level. The frequency with which the normality assumption is rejected in table 1
motivates the use of nonparametric as well as parametric tests in the data
analysis. A second motivation is that linearity did not appear to consistently
describe plots of the relation between individual variables and MOH costs.

5. Cross-sectional cost driver data analysis

The data Electronics Inc. provided pertained to 37 different facilities for

fiscal 1986. This restriction to cross-sectional data influences both the form in
which the data analysis is conducted and the inferences drawn from the
results. High correlations between cost driver variables (say MI and 442) and
MOH costs can arise for several reasons when cross-sectional data is used:

(I) High correlations reflect that Ml and M2 are the underlying cost
drivers or are highly correlated with the underlying cost drivers.
(II) High correlations reflect scale differences and/or heterogeneity among
cost functions in the sample. High correlations can arise without any causality
between the cost drivers and MOH costs at any one or more facilities. An
example of scale differences is when larger facilities have higher direct labor
dollars and higher MOH costs. The extensive literature on estimating cost
functions from cross-sectional data often attempts to factor scale differences
into a research design by examining correlation evidence after abstracting
from scale effects. Differences in cost functions in a cross-section can arise in
several ways, e.g., due to differences in manufacturing processes, or differences
in products assembled, or differences in the scale of operations. One approach
here is to partition the sample into more homogeneous subsamples.
Consider the following example of a firm with N different plants, each with
a different scale of operations. * Assume that within each plant the MOH costs
do not vary with different levels of direct labor costs. If larger plants happen
to have more direct labor costs, it is possible that in any cross-sectional sample

A table of painvise correlations among the 34 variables is available from the authors. The six
volume-based variables have higher level of correlations among pairwise correlations than do the
nineteen complexity- or nine efficiency-based variables.
Discussion of estimation issues associated with cross-sectional data is in Lev and Sunder
(1979). Benston. Hanweck. and Humphrey (1982). and Scherer (1984, esp. pp. 169-255).
l2 We are indebted to Jerry Zimmerman for this example.
320 G. Foster and M. Gupta, Cost driver amnjuis

a very high correlation between MOH costs and direct labor costs will be
found. This possibility can arise, for example, if the efficient scale of opera-
tions for each facility happens to be highly correlated (in a cross-sectional
sense) with differences in the direct labor dollars at each facility.
The research design in this paper uses several approaches to reduce the
likelihood of (II) above explaining the results. First we examine partial
correlations as well as correlation evidence. The procedure used to compute
the partial correlations will be illustrated with respect to total MOH and
direct labor dollars. Total revenues at each facility is used as the scale factor.13
The two steps in this procedure are:

Step 1: Compute residuals from two linear regressions:

MOHli = a + p. REI/; + ai, (1)

I2.Zi = y + 6 - REV, + bi, (2)
where
MOHli = total manufacturing overhead at facility i,
REV, = total revenue of facility i, and
V2.Zi = direct labor dollars at facility i.

(Appendix B provides detail definition of these variables.)

Step 2: Compute correlations between a, and bi from step 1. These correla-

tions are termed partial correlations.
Note that this procedure attributes any common correlation between the scale
variable and the cost driver variable to the scale variable.
The second approach used to reduce the likelihood of (II) above explaining
the results is to separately examine subgroups believed to have more homoge-
neous cost functions. We separately examine 15 computer facilities and 22
instrument facilities. Many personnel within Efectronics Inc. believe there is
more homogeneity in facilities within the computer group and within the
instrument group than there is ucrom the two subgroups.
The steps we take to reduce the problems of drawing inferences from
cross-sectional data about cost driver relationships at Efectronics Inc. still
leave us a very long way from making the problems minor. One extension of
our research would be to examine time-series data from a facility that had

?n a factor analysis study of the independent variables (available from the authors), revenue
was highly correlated with the first factor identified in the data base; this first factor was derived
from variables predominantly representing volume-related drivers.
 G. Faster and M. Gupta, Cost driver analysis 321

considerable time-series variation in one or more of the hypothesized cost

driver variables.

6. Correlation and partial correlation evidence

This section reports correlation and partial correlation evidence on the
hypothesized relations between MOH costs and the volume-, complexity-, and
efficiency-based cost driver variables. The analysis was conducted using both
Pearson and Spearman rank correlations.
The key results of our tests are in table 2.14 Both Pearson and Spearman
rank correlations of the 34 cost driver variables with total MOH are reported.
Only Spearman correlations for each of the three MOH subcategories (pro-
curement, production, and support) are reported in table 2; summary results
of the Pearson correlations for these three subcategories are presented in the
text of this section. Fig. 4 presents plots of the relationships between total
MOH costs and a variable from each of the volume, complexity, and efficiency
cost driver categories.
One way to summarize the evidence across the cost driver variables is the %
of the 34 variables significantly correlated with MOH. Using a 0.05 signifi-
cance level, these gs are:
Pearson Spearman
MOH cost Partial Partial
category Correlations correlations Correlations correlations

Total MOH 61.8% 47.1% 76.5% 35.3%

Procurement MOH 67.6% 32.4% 67.6% 17.6%
Production MOH 58.8% 35.3% 70.6% 35.3%
Support MOH 64.7% 38.2% 79.4% 32.4%

Based on a comparison of the correlation and partial correlation evidence,

scale factors appear to explain a sizable amount of the correlation between
MOH costs and the 34 cost driver variables. For example, using the Spearman
correlation coefficient, the number of significant correlations declines from 26
out of 34 (76.5%) to 12 out of 34 (35.3%). However, even when partial
correlations are examined, there is a higher % of significant correlations
between MOH costs and cost driver variables than would be expected by
chance.
The volume-based category of cost drivers shows more consistently signifi-
cant correlations with MOH costs than do the complexity or efficiency
categories. Using a 0.05 significance level, the 4; of the variables in each

As a sensitivity check, correlations were also computed for truncated samples [deleting (i) the
top and bottom. (ii) the top 2 and bottom 2:and (iii) the top 3 and bottom 3 observations]. This
analysis did not change the inferences drawn from the correlations in table 2.
322 G. Foster and M. Gupta, Cost driver ana!ysi.s

PANEL A
TotalMOH (S Thousands)
50000

0 1000 2000 3000 4000 5000 6000 7000 8000 900010000

Direct Labor (5 Thousands)

PANEL B
TotalMOH (S Thousands)

o+ I
0 500 1000 1500 2000 2500

NumkofConsumPriceListedP~~~Iucts

PANEL C
TotalMOH (S Thousands)

20000
l * l

10000
0.
*
;;y l . . . :

1 l
q
0 10 20 30 40 50 60 70 80 90 100

#ofProductionChangeOrders/Av.Month

Fig. 4. Plots of total MOH with (a) direct labor dollars, (b) number of consumer price listed
products, and (c) number of production change orders in an average month.
 Table 2
Correlation between MOH cost pools and accounting and manufacturing variables.

Procurement Production support

Total MOH MOH MOH MOH

Category/variables P.S.b Pearson SWatmarl SDearmaD

I
Spearman Spearmarl
corr. part. Corr. Part. Corr. part. Corr. part. corr. part.

Panel A: Volume

Plunr sire
VI.1 Total manufacturing space + 0.90c 0.62 0.87 0.F 0.79 0.32 0.82 0.50c 0.W o.49c
VI.2 Avg. total headcount in
manufacturing + 0.97c 0.88 0.94= o.86c 0.91C 0.44 0.87= 0.81 0.88 0.56
VI.3 Installed machinery and equipment + 0.89 0.69 0.83 0.65 0.76 0.22 0.84 0.66 o.70c o.59c
Plunt output
v2.1 Direct labor dollars + 0.94c 0.81 0.85 0.73 0.72 0.12 0.85 0.77 0.71 0.45
v2.2 Direct material dollars + 0.79 -0.17 0.73c -0.17 0.82 -0.12 0.59c -0.14 0.78 - 0.30=
V2.3 Total ending inventory dollars + 0.90 0.76 OMC 0.66 0.86 0.3T 0.72 0.57 0.89 0.68=

Panel B: Complexity

Product design complexibility

Cl.1 # of parts nos. on materials
record file + 0.70c o.35c o.68c 0.17 0.73c 0.10 0.62 0.20 0.66 0.23
CI.2 Avg. prod.: # of material
structure levels + 0.33= o.34c 0.28d 0.21 0.28d 0.11 0.26d 0.20 0.34 0.25d
Cl.3 Avg. prod.: Total # of part numbers + 0.15 0.11 0.31C 0.13 0.45c 0.45 0.18 0.16 0.38 - 0.06
Procurement complexity
c2.1 Total number of vendors + 0.25d - 0.01 0.43= - 0.09 0.47 -0.12 o.34c -0.12 o.45c 0.08
c2.2 # of part numbers representing 80%
of usage 0.20 0.38 0.3T 0.23 0.36 0.16 0.34c 0.20 0.35E 0.21
C2.3 Avg. number of purchase orders/
month 0.61 0.4F o.74c 0.12 o.75c 0.29d 0.67 0.05 0.68 0.13
C2.4 S of parts inspected on receipt 0.12 -0.13 0.16 0.00 0.21 0.24d 0.13 -0.11 0.22d 0.16
c2.5 % of parts preformed before
value-added 0.21 0.05 0.19 0.30 0.13 0.01 0.17 0.23 0.31 0.39
 P

Table 2 (continued)
-
Procurement Production support
Total MOH MOH MOH MOH
Category/variables P.S.b Pearson Spearman *arman Spearman
corr. Part. Corr. Part. corr. Part. corr. Part. corr. Part.

hfanuji2cturing compkxi~
process
c3.1 ExtemaIsubcontractingas46
of direct material s - 0.42 0.3T 0.20 0.38c 0.20 0.24 0.32 0.44 0.09 0.06
C3.2 Corp. subcontracting as 96
of direct material s - -0.12 - 0.06 - 0.08 -0.07 0.04 0.16 -0.14 - 0.05 -0.04 -0.04
c3.3 Avg. # of material flow transaction/
month + 0.48= 0.11 0.52= 0.11 0.W - 0.04 0.42 0.14 0.59c 0.21
Product range complexi~
c4.1 # of products on consumer price list + 0.10 0.21 0.35= 0.5T 0.20 0.19 0.36 0.W 0.38f 0.59=
c4.2 Avg. # of options shipped/month + 0.29 - 0.29d 0.46 -0.15 0.47E -0.10 o.45c -0.10 0.36 0.04
c4.3 Avg.#of ac4xssoriesshipped/
month + 0.29 - 0.36 0.67E - 0.17 0.62 -0.2P o.59c -0.12 0.68= 0.06
c.4.4 # of CPL products with 80%
of business + 0.29 0.58c 0.42c 0.65 0.22 0.20 0.W 0.62 0.36 0.61
c4.s # of new products introduced
this year + 0.16 0.30= 0.41= 0.42 0.34 0.13 0.40= 0.40 0.41= 0.45
Distributionmmplexiry
cs.1 Avg, # of customer orders
P=e=d/mon& + o.55c -0.00 0.65 -0.05 0.67 -0.04 0.W -0.07 osO= 0.08
cs.2 % of orders which were intemal - - 0.23 -0.88E -0.12 -0.22 -0.16 -0.15 -0.20 - 0.26d - 0.05 - 0.07
cs.3 Total number of customers + 0.20 0.17 0.35= 0.00 0.5T 0.36 0.3T 0.06 0.29E - 0.28d
 Table 2 (continued)

Procurement Production Support

Total MOH MOH MOH MOH
Category/variables P.Sb Spearmall Spearman Spearman Spearmaa
corr. Part. corr. Part. corr. Part. corr. Part. corr. Part.

Panel C: Ef/ierq
Manufactuhg ejkiencv
El.1 Avg. prod.: Cycle ti&in days + 0.56 0.26d 0.49= 0.10 0.34= -0.21 0.56 0.19 0.37 0.21
El.2 %ofmfgengtimeonproccss
improvement - -0.17 -0.33c -0.15 -0.29d -0.07 -0.04 -0.15 -0.26d -0.12 - 0.25d
El .3 % of CIM effort on quality/process
improvement - - 0.08 -0.14 -0.14 -0.30c -0.11 -0.47c -0.14 -0.18 -0.12 -0.14
Nonvolue-added activities
E2.1 Months of supply of inventory
maintained + 0.26d 0.33= 0.30= 0.49c 0.22d 0.17 0.27d 0.4T 0.40= 0.50=
E2.2 WIP as !S of total ending inventory + 0.39= 0.09 0.39= o.39c 0.30= 0.21 0.46= 0.43= 0.17 0.13
E2.3 # of production chauge orders
avg. month + 0.34= 0.29d 0.46 0.27d o.43c 0.28d 0.48 o.34c 0.40= 0.17
E2.4 !b products built to stock + 0.40c -0.17 0.46= -0.17 0.43= -0.11 0.38c -0.21 0.47 -0.15
E2.5 Total rework dollars + 0.3F 0.27d 0.38E 0.20 0.37c 0.05 0.27d 0.16 0.23d
E2.6 Total scrap dollars + 0.43= 0.12 0.34= 0.20 0.30c 0.01 0.28d 0.19 :::. = 0.07

Corr. = correlation between hfOH costs and @deflated) cost driver variable. Part. = partial correlation between MOH cost and cost driver
variable; partial correlations computed using two-step procedure described in text (revenues used as the scale variable). One-tailed r-test is used to test
thehsignificance of Pearson correlation coefficients. One-tailed z-statistic is used to test sigoificance of Spearman correlation coeffici*ts.
Pwdkted sign.
csignikant at 5% level.
d .
Squiticant at 10% level.
326 G. FasterandM. Gupta,Costdriver anoiysis

category that are significantly correlated with total MOH costs are:
Pearson Spearman
Cost driver category Partial Partial
of variables Correlations correlations Correlations correlations

Volume-based (6) 100.0% 83.3% 100.0% 83.3%

Complexity-based (19) 41.4% 47.4% 68.4% 26.3%
Efficiency-based (9) 77.8% 22.2% 71.8% 33.3%

The only volume-based cost driver not significantly correlated with MOH
costs when partial correlations are examined is direct material dollars.
The highly significant correlations l5 between MOH costs and direct labor
dollars is surprising to many, especially given that direct labor (as defined by
Electronics Inc.) comprises only 6.6% of total manufacturing costs. However,
Electronics Inc. is not highly automated in its manufacturing. Depreciation
comprises less than 10% of production MOH and is only the sixth most
important subcategory of production MOH (see fig. 2). The direct labor work
areas in many of Electronics facilities appear to be labor-paced rather than
machine-paced. l6

6.1. Computer facility and instrument facility subsamples

During interviews with personnel at Electronics Inc., comments were fre-

quently made about differences in the processes or products at computer
facilities vis-a-vis instrument facilities. Of the 37 facilities in our data base, 15
are classified as assembling computer-related products and 22 as assembling
instrument-related products. The analysis underlying table 2 was separately
replicated for the 15 computer facility sample and for the 22 instrument
facility sample. Both samples yielded similar inferences to those noted previ-
ously for the full 37 facility sample. For example, the % of the variables in
each category that are significantly correlated, at the 0.05 level using Pearson
correlations are:
Computer facilities Instrument facilities
Cost driver category Partial Partial
of variables Correlations correlations Correlations correlations

Volume-based (6) 100.0% 83.3% 100.0% 100.0%

Complexity-based (19) 36.8% 21.1% 31.6% 21.1%
Efficiency-based (9) 77.8% 22.2% 77.8% 22.2%

When computing these correlations, we follow the Electronics Inc. treatment of direct labor
payroll taxes and benefits (DLPTB) as a component of production MOH. The inferences drawn
from table 2 were unchanged when DLPTB was included as a component of direct labor.
16A labor-paced manufacturing environment is where worker dexterity and productivity deter-
mine the speed of production. In a machine-paced manufacturing environment machines conduct
most (or all) phases of production; workers focus their activity on the minimization of machine
problems rather than on the actual operations of the machines. See Homgren and Foster (1987,
pp. 450-451) for further discussion.
 G. Farterand M. Gupta, Cost driver anabsis 327

There is strong evidence supporting volume-based cost drivers in both subsam-

ples. In neither subsample is there consistently significant evidence supporting
complexity- or efficiency-based cost drivers.

7. Discussion of results
Possible explanations for the volume-based variables having high correla-
tions with MOH costs include:
(1) Volume-based variables are important cost drivers for MOH at Elec-
tronics Inc. There is evidence to support this proposition. Some subcategories
of total MOH are directly related to volume-based variables such as direct
labor dollars, e.g., direct labor payroll taxes and benefits. Plant tours at
Efectronics Inc. facilities provided insight into the observed high correlations
for the total headcount in manufacturing variable. Activities at many MOH
subcategories are highly labor-intensive, e.g., materials purchasing and process
engineering. The importance of headcount as an explanatory variable means
that controlling MOH costs at Electronics Inc. translates in large part to
controlling the variables that drive headcount.
(2) High correlations are an artifact of methodological problems with the
use of cross-sectional data. Section 5 discusses the problems in more detail.
Given the data available to us and our limited knowledge of cost functions in
the electronics industry, the steps we take in section 6 to reduce problems
associated with scale effects and nonhomogeneous cost functions still leave us
a long way from making the problems with examining cross-sectional data
minor.
(3) The volume-based variables found to be significantly correlated with
MOH are themselves driven by complexity or efficiency variables.
The explanations for the limited empirical support for complexity and
efficiency variables include:
(1) Complexity and efficiency variables are indeed less significant cost
drivers than are volume-based variables at Electronics Inc.
(2) The complexity and efficiency notions are more imperfectly operational-
ized by the variables examined in this research than is volume. Consider
manufacturing process complexity. One area not included in the questionnaire
relates to technical uncertainties associated with manufacturing. Some Efec-
tronics Inc. facilities have very simple assembly-type operations. Other facili-
ties are utilizing frontier technology for which many process manufacturing
issues are yet to be resolved. It is likely that these differences result in different
levels of MOH. (These differences also increase the inference problems arising
from production function differences across the 37 facilities examined.)

See Ball and Foster (1982) for further discussion of proxy problems in empirical research in
accounting. An excellent basic reference is Cook and Campbell (1979).
328 G. Fvster and M. Gupta, Cart driver analysis

(3) The complexity and efficiency variables examined are less consistently
measured in each facility than are the volume variables. This problem is
especially severe in a questionnaire where some questions relate to items not
systematically recorded by all facilities. For example, very few facilities of
Efectronics Inc. have on-line recording of production cycle time. Even where
variables are recorded on-line, Electronics Inc. operates with a high degree of
decentralization and devotes few resources to developing uniform definitions
of manufacturing variables across their facilities. It is of interest that interfacil-
ity uniformity problems are likely to be greater for the complexity and
efficiency variables than for volume-based variables such as headcount, rev-
enue, and direct material dollars. For many volume-based variables there are
institutionalized pressures from nonmanufacturing sources for the develop-
ment of uniform data bases (e.g., for reporting of labor statistics to external
bodies and from internal and external auditing procedures).

8. Comments on field-based research in management accounting

This section notes some insights gained during the research that have been
given limited recognition in the field-based management accounting literature.

8.I. Limitations arising from incomplete knowledge about underlying

cost functions

The research in this paper clearly is exploratory. At present, we do not have

a rich literature to guide us in identifying MOH cost functions in organiza-
tions. We are especially sensitive to two areas, over and above those discussed
in section 5: omitted variables and aggregation issues.
l Omitted variables: Section 2 noted that the volume (V), complexity (C),
and efficiency (E) variables may not fully capture all the variables that
drive MOH at Electronics Inc. For example, additional (omitted) variables
could relate to the work force (e.g., prior training and the use of quality
circles) and to incentive-compensation practices. The effect wilI be biased
estimates of the importance of the V, C, or E variables if these variables are
correlated with the omitted variables.
l Aggregation issues: This paper reports results for the total MOH cost
category and for the three components of total MOH that Eiecfronics Inc.
reports in its internal accounting system - procurement, production, and
support. These cost pools may not be the appropriate level of aggregation as
regards identification of cost drivers. For example, one subcategory (X) of
production MOH may have a positive relation with product complexity,
while another subcategory (Y) may have a negative relation. Aggregating
cost pools X and Y to derive production iUOH before analyzing the data
 G. Farter and M. Gupta, Cast driver ana(vsis 329

for cost driver relations potentially could result in insignificant correlations

between a variable representing product complexity and production MOH.
An extension of the research in this paper would be to extend the analysis to
each of the 23 subcategories within the procurement, production, and
support categories - see fig. 2.
The examples given in this paper to illustrate inference problems in cost driver
research have focused on cross-sectional data ,analysis. An alternative ap-
proach is to use time-series data from one facility. One advantage of a
time-series approach is the ability to examine how variations in the cost driver
variables are associated with variations in MOH. Time-series analysis, how-
ever, would need to address some challenging experimental issues:
l Specifying the response time between changes in cost drivers and changes in
MOH. Month-by-month variations in complexity variables are unlikely to
have simultaneous monthly adjustments in process design engineers, pro-
curement officers, etc. It is also likely that the response time is of nonuni-
form length across individual MOH categories. Moreover, adjustments may
be made in a step-function mode rather than in smal%aiements.
l Structural change at each facility. Time-series analysis typically assumes
observations are drawn from a process with minimal structural change.
Electronics Inc. personnel in several facilities noted that major changes in
manufacturing operations have been made several times in the last five
years, e.g., through corpomte decisions to switch the manufacturing of
products to different facilities (one of the few examples of centralization at
Electronics Inc.) or the adoption of-just-in-time manufacturing.

It is our belief that neither cross-sectional nor time-series data should be

exclusively used in cost driver empirical research.

8.2. Nonsystematic collection of information on key variables

One motivation for Electronics Inc. using a questionnaire approach was the
nonavailability in existing reports of information on potential cost drivers at
each facility. Many manufacturing personnel expressed little enthusiasm for
efforts to expand the data they collect to include variables that were (at best)
potential cost drivers. Several items in the questionnaire asked information
about the time allocation of product designers and manufacturing engineers.
There are strong cultural biases at Electronics Inc. against institutionalizing
the collection of this information on an hourly, daily, or even weekly basis.
The use of automatic data retrieval mechanisms (e.g., bar codes) is playing
an important role in increasing the amount of shop floor data available.
However, in several key areas (e.g., production cycle time) very little data
currently is being systematically recorded at Electronics Inc. This data non-
330 G. Faster and M. Gupta, Cart driver analysis

availability issue is likely to remain a major problem in field-based manage-

ment accounting research.

8.3. Recognizing how corporate policy aflects aspects of the research

Field-based research using data from a single organization can encounter
specific organization norms that affect the research design or the inferences
drawn from the research results. Two areas that arose in our research at
Electronics Inc. are the lifetime employment policy and the decentralization
policy.

l Electronics Inc. has a policy of not firing full-time employees. Where

individual facilities encounter reduced workforce demand, efforts are made
to relocate the workforce to other facilities. However, typically this reloca-
tion is not made quickly. The result is that facilities recently experiencing
sizable declines in demand for their products may have higher MOH costs
than would be the case had the life-time employment policy not been m
existence.
l Electronics Inc. is highly decentralized. This policy typically creates more
problems with research using cross-sectional data than with research using
time-series data from a single facility. Electronics Inc. has not devoted
sizable resources to developing a uniform data base covering manufacturing
statistics. Individual facilities can differ in what variables are tracked and
how those variables are defined and measured. The result is additional
noise in the data to be examined, This problem is less severe in several
other organizations that the researchers have interacted with. These organi-
zations operate with a more highly centralized manufacturing policy and
have monthly reports that include the same manufacturing statistics col-
lected from every facility (based on uniform reporting rules).

8.4. Importance of triangulation

Field research monographs stress the importance of using triangulation, i.e.,
the combined use of several approaches to gaining field evidence.18 This paper
relied on plant tours and interviews with plant and corporate personnel as well
as data analysis. Plant tours enabled us to observe many areas where MOH
costs are incurred. Interviews enabled us to probe issues related to data
collection and how budgeting operates at Electronics Inc. and to increase our
knowledge of the manufacturing operations. In addition, the interviews en-

*Additional discussion of field based research issues is in Yin (1984) and Harvard Business
School, The Characteristics of @ml Clinical Research - extracts reprinted in Bruns and Kaplan
(1987, pp. S-7).
 G. Faster and M. Gupta,Cast driver analysis 331

abled us to have a set of contacts to discuss issues that arose in the preliminary
data analysis.

9. summary
The accounting, manufacturing, and strategy literatures are paying increas-
ing attention to manufacturing overhead cost drivers. This paper is an early
attempt to present evidence on the hypothesized relations. Most analysis to
date has been either prescriptive (e.g., suggestions as to the important drivers)
or illustrative (e.g., showing how product costs differ if machine setup is an
important driver).
Subject to caveats regarding the use of cross-sectional data from plants
using different production processes, strongest empirical support is found in
the Electronics Inc. MOH data for volume-based variables, e.g., total head-
count in manufacturing and direct labor dollars. There is limited empirical
support for complexity- or efficiency-based variables, once controls are made
for scale differences across the facilities. Plant tours and interviews with
Electronics Inc. personnel highlighted two possible explanations for this find-
ing:
1. the complexity and efficiency notions are more imperfectly operationalized
by the variables examined in this research, and
2. the complexity and efficiency variables examined are less consistently
measured in each facility than are the volume variables.
Subsequent empirical research on MOH cost drivers faces the challenge of
controlling for differences in using data from different production processes
while seeking ways to reduce the importance of these two explanations for any
observed findings.

Appendix A: Questionnaire data screening procedures

The questionnaire was relatively long (16 pages); a maximum of 292 data
items could be obtained from each questionnaire. Issues that arise in examin-
ing this data include:
(1) Potential differences in the interpretation of terms. Respondents were
given a person to contact to answer queries related to the questionnaire. That
person received 41 phone calls. A log was kept on these queries. Three areas of
the questionnaire caused the most problems:
l Questions related to average product and the number of separate products
at each facility. Some respondents believed there was no average product.
Respondents also noted that minute product variations might technically
give rise to numerous listed products when there was over 95% commonality
332 G. Foster and M. Gupta, Capt driver ana@s

of parts in all products.. . should all these variations be called separate

products?
l Questions related to information not currently recorded at the facility on a
systematic basis, e.g., production cycle time.
l Questions that appeared to relate to only small sections of the facility but in
other facilities related to the whole facility.

(2) Data not applicable to the facility. For example, questions relating to
the assembly process were not applicable to divisions only having fabrication
operations.

(3) Data not available because the facility collects data at a more aggregate
level or in a different format than that requested by the questionnaire. For
example, one facility reported the direct labor supervision, other indirect
labor, and production management subcategories of production MOH as an
aggregate figure. Direct labor dollars were reported for 33 of the 37 facilities;
4 facilities no longer separately track direct labor, including it in production
MOH.

(4) Data not available because the facility did not complete all items in the
questionnaire for which they had the data internally. Facilities at Electronics
Inc. operate with a high degree of decentralization and do not always fully
respond to corporate information requests from corporate headquarters. The
response rate for individual items was higher for the first half of the question-
naire than for the second half. (Many Electronics Inc. personnel interviewed
expressed amazement at the relatively high overall response rate. The per-
ceived importance of the topic was frequently given as the reason why
facihties devoted considerable resources responding to the questionnaire.)

Out of 10,804 possible data points there were 1,751 not applicable and 907
not available; 8,146 data points were available for analysis.

Appendix B: Description of cost driver variables in data base

B. I. Manufacturing overheadcost categories

MOHZ: Total manufacturing overhead dollars (in $000s)
This represents sum of three manufacturing overhead cost categories at the
facility which are defined below.
MOHZ: Procurement overhead dollars (in $000s)
This represents overhead costs associated with procurement functions at the
facility.
 G. Farter and A-f. Gupta, Cart driver ana(wis 333

MOH3: Production overhead dollars (in $000s)

This represents overhead costs associated with production functions at the
facility.
iUOH4: Support overhead dollars (in $000s)
This represents overhead costs associated with functions to support procure-
ment or production functions at the facility.
Revenue represents total revenue dollars (in $000s) at the facility. This is
used to proxy for the size of the facility in the analysis. Thirty-four cost driver
variables in three categories of cost drivers are examined: volume-based,
complexity-based, and efficiency-based variables.

B.2. Volume-based variables

1. Plant size
V1.2: Total manufacturing space (in square feet)
VZ.2: Average total headcount in manufacturing
This includes direct labor headcount and all other personnel in manufacturing.
VZ.3: Installed machinery and equipment (in $000s)

2. Plant output

V2.2: Direct labor dollars (in $000~)

V2.2: Direct material dollars (in $000s)
V2.3: Total ending inventory dollars (in $000s)
A positive correlation between MOH and each of these six variables is
hypothesized.

B.3. Complexity-based variables

1. Product design complexity

Cl.1: Number of part numbers on materials record file
This represents various different parts used and supported in the bill of
materials file at the given facility.
CZ.2: Number of material structure levels in an average product
This represents the number of different processes an average product passes
through at the facility.
CZ.3: Total number of part numbers in an average product
This represents the number of different parts being used in an average
product.
334 G. Fvster and M. Gupta, Cost driver analysis

2. Procurement complexity

C2.Z: Total number of vendors

This represents total number of suppliers of materials being used at the
facility.
C2.2: Number of part numbers representing 80% of usage
This represents the number of part numbers which constitute 80% of materials
being used at the facility.
C2.3: Average number of purchase orders per month
C2.4: % of parts inspected on receipt
C2.5: % of parts preformed before value added
Most of the time there are minor operations performed on parts before they
can be used in assembly activities, e.g., bagging, repackaging, etc. These
activities are not part of production process but are part of the procurement
process.

3. Manufacturing process complexity

C3.Z: External subcontracting as a % of direct materials purchases
This is % of material purchases that represent work which has been done by an
external manufacturer or subcontractor.
C3.2: Corporate (within Electronics Inc.) subcontracting as a % of direct
materials purchases
C3.3: Average number of material flow transactions per month
This represents the number of transactions performed in manufacturing in an
average month.

4. Product range complexity

C4.1: Number of products on consumer price list
This represents only products which are sold to outside buyers. This does not
include products manufactured only for the use by another internal division at
Electronics Inc.

C4.2: Average number of options shipped per month

C4.3: Average number of accessories shipped per month
Both C4.2 and C4.3 represent only options and accessories sold to outside
buyers.
C4.4: Number of consumer price listed products with 80% of business
This represents the number of consumer price listed products which are
responsible for 80% of the revenue at the facility.
 G. Foster and M. Gapta, Cmt driveranalysis 335

C4.5: Number of new products introduced this year

This includes consumer price listed products, products sold only to internal
divisions of Electronics Inc., and products developed but not marketed.

5. Distribution complexity

C5.Z: Average number of customer orders processed per month

This represents average number of shipments per month to both external and
internal customers.
C5.2: % of orders for internal divisions of Electronics Inc.
This represents the K,of sales made to internal divisions of Electronics Inc.
C5.3: Total number of customers
The hypothesized positive relation between MOH and complexity predicts a
positive correlation for sixteen of the nineteen complexity variables. For three
variables, a negative correlation with MOH is predicted by the complexity
hypothesis: C3.1, C3.2, and C5.2. For the C3.1 and C3.2 variables, higher
percentages translate to lower proportions of the total activity on products
done within the facility whose MOH costs are being examined. The presump-
tion underlying a negative correlation for C5.2 is that sales to internal
divisions require less overhead-related activity than do external sales - this
proposition was put forward at several facilities of Electronics Inc.

B. 4. E$ciency -based variables

1. Manufacturing eficiency

El. 1: Average production cycle time in days

El.2: % of manufacturing engineering time spent on process improvement
This represents percentage of manufacturing engineering time which is being
spent on modifying or improving existing manufacturing processes at the
facility.

EZ.3: % of computer-integrated manufacturing (CIM) effort spent on quality

and process improvement
This represents percentage of CIM time which is being spent for quality
control, quality improvement, and process improvement.

2. Nonvalue-added activities

E2.1: Months of supply of inventory maintained

E2.2: Work-in-process (WIP) as % of total ending inventory
336 G. Farter and M. Gupta, Cast driver anOrysis

E2.3: Number of production change orders in an average month

This represents any changes made in the design or the production process for
a product after it is ready for production or is under production.

E2.4: % of products built for stock

This represents products built for inventory as opposed to being built to
demand.

E2.5: Total rework (in $000s)

This represents dollars spent on jobs which were performed on products which
were found to be defective or not within certain tolerance limits.

E2.6: Total scrap (in $000s)

The hypothesized negative relation between MOH and efficiency predicts a
negative correlation between MOH and two of the three manufacturing
efficiency variables: EZ.2 and EZ.3. These variables capture activities that aim
to increase manufacturing efficiency (with an hypothesized decrease in MOH).
All the other efficiency-based variables are hypothesized to have positive
correlations with MOB, these other variables are measured such that higher
values imply lower efficiency levels.

References
Abegglen, J. and G. Stalk, 1985. Kaisha: The Japanese corporation (Basic Books, New York, NY).
American Electronics Association, 1985, 1985-86 operating ratios survey (American Electronics
Association, Palo Alto, CA).
Ball, R. and G. Foster, 1982, Corporate financial reporting: A methodological review of empirical
research, Supplement to Journal of Accounting Research 20,161-234.
Banker. R.D. and H.H. Johnston, 1988, Cost driver analysis in the service sector: An empirical
study of U.S. airlines, Working paper (Carnegie Mellon University, Pittsburgh, PA).
Banker, R.D.. SM. Datar, S. Kekre, and T. Mukhopadhyay, 1989, Costs of product and process
complexity, Working paper (Carnegie Mellon University, Pittsburgh, PA).
Benston, G.J., G.A. Hanweck, and D.B. Humphrey, 1982, Scale economies in banking: A
restructuring and reassessment, Journal of Money, Credit, and Banking 14,435-456.
Berliner, C. and J.A. Brimson, 1988, Cost management for todays advanced manufacturing: The
CAM-I conceptual design (Harvard Business School Press, Boston, MA).
Bruns, W.J. and R.S. Kaplan, eds., 1987, Accounting and management: Field study perspectives
(Harvard Business School Press, Boston, MA).
Capettini, R. and D.K. Clancy, eds., 1987, Cost accounting, robotics, and the new manufacturing
environment (American Accounting Association, Sarasota, FL).
Clark, K.B., R.H. Hayes, and C. Lorena, eds., 1985, The uneasy alliance: Managing the productiv-
ity-technology dilemma (Harvard Business School Press, Boston, MA).
Cook, T.D. and D.T. Campbell, 1979, Quasi-expeiimentation: Design and analysis issues for field
settings (Rand McNally, Chicago, IL).
Cooper, R. and R.S. Kaplan, 1987, How ccst accounting systematically distorts product costs, in:
W.J. Bruns and R.S. Kaplan, eds., 1987, Accounting and management: Field study perspec-
tives (Harvard Business School Press, Boston, MA) 204-228.
Harvard Business School, 1985, The characteristics of good clinical research, Mimeo.
Hayes, R.H. and SC. Wheelwright, 1984, Restoring our competitive edge: Competing through
manufacturing (Wiley, New York, NY).
 G. Foster and hf. Gym, Cast ariver analysis 337

Hayes, R.H.. S.C. Wheelwright, and K.B. Clark, 1988, Dynamic manufacturing: Creating the
learning organization (The Free Press, New York, NY).
Horngren, C. and G. Foster, 1987, Cost accounting: A managerial emphasis, 6th ed. (Prentice-Hall,
Englewood Cliffs, NJ).
Johnson, H.T. and R.S. Kaplan, 1987, The rise and fall of management accounting, Management
Accounting, Jan.. 22-30.
Lev. B. and S. Sunder, 1979. Methodological issues in the use of financial ratios, Journal of
Accounting and Economics 1,187-210.
Miller, J.G. and T.E. Vollmann, 1985, The hidden factory, Harvard Business Review, Sept./Ott..
142-150.
National Association of Accountants, 1986, Cost accounting for the 90s: The challenge of
technological change (National Association of Accountants, Montvale, NJ).
Porter, M.E., 1985. Competitive advantage (The Free Press, New York, NY).
Scherer, F.M.. 1984. Innovation and growth: Schumpeterian perspectives (MIT Press, Cambridge,
MA).
Schonberger, R.J., 1982. Japanese manufacturing techniques: Nine hidden lessons in simplicity
(The Free Press, New York, NY).
Schonberger, R.J.. 1986, World class manufacturing: The lessons of simplicity applied (The Free
Press, New York, NY).
Siegel. S., 1956, Nonparametric statistics for the behavioral sciences (McGraw-Hill, New York,
NY).
Yamane. T.. 1973, Statistics: An introductory analysis (Harper & Row, New York, NY).
Yin, R.K., 1984, Case study research: Design and methods (Sage Publications, Beverly Hills, CA).